Diamond houses, local traders, realtors and petty 'assistants' come together to evade tax

Diamond houses, local traders, realtors and petty 'assistants' come together to evade tax

MUMBAI: When officials of the Mumbai income-tax investigation wing stumbled upon a handful of bank accounts with wild entries, they first thought these were typical money-laundering deals one associates with the seedy underbelly of the financial capital.

But as they dug deeper into the money flow, they could slowly piece together an amazing web of transactions that involved diamond houses, construction firms, local traders and an army of lackeys who do nothing other than lending their names for small money.

These disparate players come together in circuitous transactions that are carried out to escape tax as well as funnel unaccounted cash into audited accounts of regular businesses. "It took us a while to get the complete picture...We have our eyes on some people. The investigation is on," said a senior official of the Income-Tax Department.

The chain starts with some diamond firms that regularly import rough stones on 3-6 months' credit. But the simple trade is done differently. The import lands in five consignments: on paper, only one of these is linked to the diamond houses.

Assistants Front for Diamantaires

The other four consignments are received by four 'assistants' of the diamond firm. These assistants, who do not have the means and creditworthiness to import, act as fronts for the diamantaire.

Once Customs formalities are over and the assistants take delivery of the diamonds, the stones are handed over to the diamond house, which pays them nothing but a small fee for their services. The four assistants (or the fronts), on the other hand, do not have physical diamond in their possession, but have diamonds on the books of their entities that have acted as importers on behalf of the real diamond company.

For the diamond house, it's a ploy to lower turnover and evade tax in future. But the chain of transaction does not end here.

QUID PRO QUO WTH LOCAL TRADERS

The next set of players that participates in the transaction is local traders and jewellers who typically use cash to buy diamonds. These are people who need purchase bills to formalise their onward sale and regularise the books. Here, the 'assistants' come handy. The 'assistants', who took delivery of the imported rough diamond before passing them on to the diamond companies, are in a position to provide these traders with bills - simply because they are the official importers.

The deal that takes place at this point involves the local traders giving cheques (in favour of the assistants) to the assistants and collecting purchase bills from them. But these are not genuine trades and no real diamonds have been 'sold' by the assistants against genuine cheques they receive from the traders.

Understandably, the traders have to figure out a way to get their money - which they have paid in cheques - back. This is where the third group of players joins the game.

THE FINAL LEG

These are real estate firms, construction outfits and even a few infrastructure companies with big projects and a sizeable amount of unaccounted cash. They look for opportunities that enable them to route the cash they have into the official books. As long as the cash lies outside the books, they are not in a position to shore up the capital of their companies. What makes it happen is a multi-layered transaction between the assistants (of the diamond firms), the local traders and these construction/infrastructure companies.

This is what they do:

*First, the construction company gives cash to the assistant, who in turn hands it over to the local traders. This completes one leg of the transaction: the local traders get back the money (in cash) that they have paid (in cheque) earlier to the assistants; the traders have no qualms in accepting sack loads of cash because they are used to dealing in cash.

*Second, the assistants pay in cheque to subscribe to shares issued by the construction company. Since the money received through cheque from the local traders is still in their accounts, they have no problem in paying the share application money. Then, after a few months, the promoters of the construction company buy back the shares at nominal price from the assistants.

Thus, these companies infuse capital by receiving cheques from the assistants and then the promoters pay them back at a fraction of the price. (Here, the assistant may have paid Rs 500 a share - a premium of Rs 490 - while the promoters buy the shares back at Rs 10).

If the construction company is small and unlisted, the transaction ends here. But if it's a large company - particularly if it's a listed one - then the buyback of shares by promoters at an abnormally low price would face regulatory hurdle s and inevitably draw attention; it would be impossible to explain how a company's valuation could dramatically crash in just a few months. Moreover, new laws have empowered the tax office to question such deals.

HIDING THE MONEY FLOW

So, another layer of transaction is added to keep the taxman away. The parties concerned - assistants and construction firms - break down the transaction by employing the services of intermediaries (between the assistants and the construction companies). These intermediaries are shell companies with little net worth.

"What happens here is interesting...and it's done to hide the transaction," said another tax official.

An assistant buys shares of the intermediary company by paying 500 apiece. Now, suppose, each share of the construction company (which is at the end of the chain) is valued at Rs 20; any deal that happens on the share of this company cannot significantly differ from the traded price of Rs 20. So, the intermediary invests the money it receives from the assistant to buy 25 shares of the construction company for Rs 500.

After a few months, the promoter of the construction company pays Rs 10 to buy one share of the intermediary shell company, which in turn is holding 25 shares of the construction company. This shell company, though a separate entity, is now owned by the promoter of the construction firm. These unheard of intermediaries help to mask the deal that would otherwise evoke suspicion.

These multiple transactions serve each player. The assistant squares his books by investing the money in shares and later selling the shares back. With this money he pays for the 'imports'. The local trader pays for fake purchase bills and gets back its funds in cash. The real estate company converts its black money into white. And the diamond firm, which started it all, pays lower tax.